Where to Buy an Investment Property – The A, B, C, D Rating System

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As a real estate investor, there are few more important decisions than where to buy an investment property. It’s like making sure you have fertile soil before you plant seeds for your crops.

Your “farming” of good investments begins by understanding the big picture criteria for the best investing locations within your country and region. But within your local market, you also need to decide if you’ll invest in A, B, C, or D class real estate locations and properties. Like report cards in school, certain locations and certain properties receive an informal grade from investors and brokers.

But unlike bad grades in school, it’s actually possible to make money in any of these locations depending on your real estate niche and particular financial goals.

So in the rest of this article, I’ll explain how this informal grading system works. And I’ll also show you how to apply the system to your investing using some real-world examples.

The A, B, C, D Rating System for Real Estate

If you hang around real estate investors long enough, you’ll hear someone say “that’s an A location – it’s incredible!” Or someone else might say “that was a D property, it was too much hassle!”

What exactly do they mean by that?

The first thing to know is that the investor could be talking about one or both of:

the location

the property itself

So, a C property (not as good) might be in an A location (the best). Or it could be an A property (the best) in an A location (the best).

This practice originated from the commercial real estate world. Commercial investors and brokers typically use A, B, C ratings when referring to multiunit, office, retail, or other commercial space. It helps them compare the quality of one location or building to another.

Those of us in the small, residential investment world often throw in a D rating – typically for something in a very challenging location!

But it’s important to realize that this A, B, C, D rating system is VERY subjective. There is no national, standardized system of ratings. Your appraiser won’t officially use this rating in his or her report.

The rating system is primarily useful because it helps you to compare your building or location to others in the area. And by understanding where the property fits into the overall market, you can decide if it fits your particular strategy. Then you can also use the rating to make sure you pay the right price.

I’ll talk more about price in the later section on cap rates. But for now, let’s look at each of the ratings and some examples so that you better understand what they mean.

Class A Locations

Class A property means the best. As a location, the best means the most desirable, in-demand parts of your town.

For example, I invest in the small college town of Clemson, South Carolina. So for residential rental properties, the Class A locations are as close to campus and to the downtown restaurant/bar district as possible. This allows students or faculty to walk or bike to campus and be close to all the fun and action.

Here’s the map of one Class A location in my town. The little red house icon is where I happened to buy one of my best deals – a small multiunit rental property.

And even though the distance is critical in my case, keep in mind that there are other location factors that also matter. For example, this Class A location has old trees, safe streets, and lots of character. They all combine to make it an emotionally appealing place to live for tenants or owner occupants.

Every city or town will have a slightly different definition of a Class A location. Your job as a professional investor is to find out what that means for your town.

Class A Buildings

Class A building typically means it’s brand new or remodeled and has no functional obsolescence (i.e. bad floor plans, outdated finishes, etc). In the case of apartment buildings, there are also usually a lot of luxury amenities like pools and workout gyms.

Here’s an example of a Class A apartment building called 114 Earle in my town (it also happens to be in a Class A location!):

Class A multi-unit apartment with brand new construction, quality finishes, modern layouts – Photo Credit 114 EarleClass A apartments usually have luxury amenities (wouldn’t you like to live here during college?!) – Photo Credit 114 EarleGyms and other amenities are common in Class A apartments – Photo Credit 114 Earle

Although most commercial investors wouldn’t lump single-family houses into these classifications, I would also put a brand new (or fully remodeled) house into Class A as well.

But not everything can be Class A. So, let’s look at what it means to be Class B.

Class B Locations

Class B is obviously one notch below Class A. It’s not the best, but it’s still very attractive.

The typical tenants have a mix of working class and professional-level jobs. Or in my case with student rentals, they’re still students but not the ones with the most expensive taste! And the rental rates hover around the average for the area.

Again using my small college town as an example, I consider the Class B locations to just be a little farther from campus and the downtown commercial district. These locations also might not have as much character or emotional appeal as Class A. But they’re still in-demand neighborhoods, typically on a local bus line, and often with good walking or biking paths nearby.

Here’s a map of one particular Class B location where I own residential units:

Class B locations are less desirable than Class A but still very attractive for tenants and buyers. This example in my town is about 1 to 1.5 miles from campus.

For single-family houses, I also consider a lot of median priced or starter home subdivisions (often with HOAs) to be Class B locations. These single family neighborhoods are attractive, safe, and in-demand. They’re usually not as luxurious as Class A neighborhoods. But Class Bs are usually more profitable than Class A as income producers.

Because Class B locations are often just outside the Class A locations, it’s possible for a Class B to turn into a Class A as the town grows. So, buy and hold properties in up-and-coming Class B areas are actually some of the most profitable long-term investments. They provide a mix of decent rental income and a large amount of appreciation. But keep in mind, it’s possible for locations to go DOWN the scale, too! So, study your market carefully.

Now let’s look at what a Class B building might look like.

Class B Buildings

Class B buildings are often the well-kept older buildings or newer buildings with fewer fancy finishes. But Class B buildings can still be very attractive (and more affordable) places to live.

In fact, my best properties are Class B buildings in Class A or B locations!

Here is an example of what I consider to be a Class B apartment complex:

This building is newer, but it’s not quite as nice as Class A. It might have vinyl siding or other entry-level finishes, for example.

The amenities of Class B buildings are also less impressive (but still satisfactory). For example, here’s an advertisement for a small group of apartments that I co-own. They are remodeled 1950s-era, brick buildings with hardwood floors. But we certainly don’t have pools, clubhouses, or other amenities.

List of typical amenities for our Class B property

I would also add a lot of older or middle-aged but well-kept single-family houses to Class B properties. But once these older properties begin to wear down too much or have large capital expenses looming (like roof and HVAC replacements), they could fall into Class C.

Class C Locations

Class C locations are typically working-class neighborhoods. You will find a mix of rental and owner-occupied properties. And the rental rates will usually be below the average for the area.

In the past, Class C locations might have been Class B or A locations, but they’ve become less popular as they age. This also happened a lot during the last 50-60 years as centers of economic activity moved from old town centers to suburban sprawl highways. The older neighborhoods near downtowns were left behind.

But these Class C locations can actually be fertile ground to find some of your best cash-flowing rental properties. As long as the neighborhood is stable or improving, you can provide affordable housing to hard-working families.

Here is a map of my area with one of the Class C locations marked:

Class C locations are typically working class, blue-collar type neighborhoods. You also find some of the best cash flow properties here.

Now let’s move on to a Class C building.

Class C Buildings

A Class C building is typically older and will likely need some repairs or major improvements in the near future. But despite their apparent wear, the building itself can still be a very good place to live.

In addition to older houses, I also include most mobile homes in this category. Yes, it’s possible to have brand new mobile homes. But they depreciate very quickly. So, most used mobile homes fit into Class C or worse.

One mistake I see many investors make with Class C properties is underestimating repairs and capital expenses. For example, I have one older 4-plex that has averaged maintenance of $70 per unit per month for over 12 years. That’s a total of $280 per month for a building that rents for $2,200 per month.

But in addition, we’ve also averaged almost $1,500 per year in capital expenses like HVAC replacements, exterior painting, roofs, etc. I rarely see investors include these capital expenses or higher maintenance costs in their upfront analysis. That becomes a problem later on because reality doesn’t care about your spreadsheet! So, be sure to run your numbers correctly on these older properties.

Class D Locations

Class D locations are a little tougher to define because there is a fine line between Class C and Class D.

These locations can sometimes be pockets within Class C neighborhoods. Or in other cases, they might be an entire area of a city or town. Typically the tenants are low-income earners and/or live in subsidized housing, although those tenants could also live in Class C neighborhoods.

One common characteristic of Class D locations seems to be a higher crime rate. I have owned properties in Class D locations (that I thought were Class C), and we were vandalized several times. We also had issues with neighbors who dealt drugs, sat around on the front porch all day (every day), and otherwise made it very difficult for us to find good tenants.

Our lovely Class D “mill house” before getting fixed upClass D house after some paint and repairs. We STILL lost money and had a lot of headaches.

There are certainly good people who live in Class D locations, often out of necessity. And some landlords still make investments work in these locations. But in my experience, the location needs to be moving towards a Class C before it becomes worth investing in.

A blogging friend of mine Lisa Phillips at affordablerealestateinvestments.com has created a niche out of owning and teaching others to own lower-income rentals. She is someone who understands the nuance of differentiating neighborhoods that can make great cash flow investments (I would call them Class C) and others that are high risk (i.e. Class D). So definitely visit her site or read her book to learn more.

It’s also worth paying attention to your local town politics and reading the local comprehensive plan. You might discover D or C locations where the city is investing large amounts of money into parks, infrastructure, and crime prevention. With enough other positive ingredients, these locations can become worthwhile investments over time.

Class D Buildings

Class D buildings are run down, typically older, and need a lot of work. Often they’re not even livable. These are your classic fixer-upper properties where a lot of money can be made.

You can find Class D properties in Class A, B, C, or D locations. And the most profitable investments happen when you buy a Class D property, invest money, and upgrade it to a property that matches its location. You can do this as a fix-and-flip strategy or as a fix-and-rent strategy.

But you want to avoid the biggest mistake, which is over-improving a building for the location. I’ve found it’s profitable to improve one level above – like a Class B property in a Class C neighborhood. But you won’t get any extra value for having a Class A property in a Class C neighborhood. You’ve got to know your neighborhood and then remodel it accordingly.

Here are some pictures of Class D properties I’ve bought and later remodeled.

Before remodel – Class D building, Class C neighborhoodAfter remodel – from Class D to Class B building in Class C neighborhoodBefore remodeling – Class D building. Class A- neighborhoodAfter remodeling – From Class D building to Class A- building in a Class A- neighborhoodKitchen of the same house before remodeling (it had water damage)Kitchen after remodeling – Class A- building in a Class A- neighborhood

Cap Rates and Classes of Real Estate

So, you’ve just learned my take on Class A, B, C, and D real estate. But don’t forget that the details of my definitions are personal. Even another investor in my own town might quibble with me about certain distinctions.

But on average, the collective opinions of local investors will create trends. And one of the clearest trends for the class of real estate is the location’s average cap rate. In other words, you can compare cap rates of different locations within a market to tell which is the best and which is the worst.

Class A locations will demand the highest prices in a given area. And for this reason, they’ll also have the lowest cap rates. This basically means on average investors are willing to accept less income for a certain property because they value the security and growth potential of its superior location.

It’s kind of like bond investors who’ll accept less income (i.e. pay higher prices) for U.S. Treasury bonds when compared to bonds from private corporations. The Treasury bonds are lower risk, so the investors pay more for them.

And as you’d expect, cap rates go up (i.e. investors pay lower purchase prices) as you move down to Class B, C, and then D locations. The lowest prices you’ll ever find will be in Class D locations. But as I’ve already explained, you may get more than you bargained for because these areas can be challenging!

To demonstrate this concept, take a look at the chart below with data from CBRE’s 2017 Cap Rate Survey. The average cap rates for class A, B, and C properties continuously go up as you get worse on the rating scale. Also, notice that the cities have different cap rates as well. You basically have Class A, B, and C cities just like you do locations within those cities!

This brings us to perhaps the most important point of this entire article. You need to understandthe Class A, B, C, and D locations and properties in your city so that you don’t overpay for your investments!

Yes, you need to run the numbers and set financial goals for each deal. But those numbers are only relevant in the context of the property class.

Some of my biggest real estate mistakes were running Class B or C numbers in a Class D neighborhood. I overpaid and lost money as a result.

And many other investors never successfully buy a property because they try to use Class C numbers in Class A neighborhoods. They don’t understand why everyone else “pays so much.”

The financial and emotional costs of my mistakes are forever burned into my brain! But I hope you can learn from my experiences and not repeat the mistakes yourself.

Conclusion

You’ve now been on a tour of Class A, B, C, and D real estate. And you’ve learned how to apply the concept to your own investing.

I hope you’ll take the concepts and practice them as soon as possible. Talk to other investors and real estate agents in your town. Ask them their opinions on locations. Create your own color-coded Google Maps as you learn more about your A, B, C, & D neighborhoods.

Then go visit and run the numbers on real properties to test out your theories. Doing is the best way to learn. Good luck!

What do Class A, B, C, & D properties look like in your town? Have you ever made the mistake of not understanding the class of your investment? I’d love to hear from you in the comments below.

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Good question on tenant reliability. My sweet spot has been in the B-/C+ locations – both with student rentals and with regular long-term rentals. For some reason it’s been a good mix of paying on time + longevity + self-sufficiency. A locations attract good payers and are easy to rent, but there is also a little more hassle (like running a higher-end hotel).

Thanks Chad .Stuff I already knew but never put on paper as you have .I have done good buying double-wides on their own small lots . 20 % cap rates , but sometimes ‘ challenging’ tenants..
I have a class D house on a good street ( ” B ” ? ) area… 21 Sirrine St Seneca . Make me an offer .
As to future appreciation , take a look at the place I’m moving to , 150 Carson rd ,the big old church ( 5500 sq ft ) on 2.2 acres and a meeting hall next door ,( I’m donating free use to the local Boy Scouts ). I paid 160 K for it , soon to be by home and down stairs will be 5 climate controlled units .

Thanks for sharing Redd. Definitely an interesting property on Carson Rd. That’s a good part of town. I’m not buying in Utica, but has it gotten better over time? Last time I looked was maybe 7-8 years ago.

Interesting to me is how neighborhoods change over the years. I’ve been buying in a great neighborhood in Philadelphia for the last 14 years (Buy, Fix, and Hold as rental). When I started, it was a D neighborhood. Now, 14 years later, it is a C+ neighborhood. Cap rates have gone way down (RE taxes have gone way up), and I am starting to get “outbid” on new purchases. (Sale price is driven higher than my preferred ROI. – I could still buy, but at a diminished return.) So, my question for you is, what are your thoughts on the current options: A) “Overpay”, and accept the diminished return – OR- B) Move to a new “up and coming” neighborhood. I know it is a personal decision, but I think the query fits in well with your excellent article above.

Great point, JKC. These definitions change over time for a particular location, as you have shown.

I think it depends on your strategy. If you need/want to buy properties with more cash flow, then yes – you’ve got to move to different locations. The nature of higher class neighborhoods is lower cap rates, typically higher appreciation, and more stability. That may work for stable investors with lots of capital or growth investors who are able to wait 10+ years, but maybe not for those who need to live off the investments.

I’m also pondering these same questions in my market JKC. I’m no longer as excited about C or D neighborhoods because I’m more in a stability mode. So, I’m having to rethink my investing goals and expectations for my current situation.

Yeah, I can rationalize the lower cap rate as a move from “wealth building returns” to “wealth preserving returns”. … but it is hard to slow down. I’m not ready to retire yet. 😉 Thanks for your answer.

Great article and synposis, Chad. Two important takeaways for me are: the one level up principle you discuss and the expectations of returns in Class A and Class C and not to mix up the two. I couldn’t help but notice the very low cap rates in San Diego in the chart! Real estate prices are incredibly high so the returns are pretty meh. There is a little area of town I’ve identified as a possible future place to invest which I would say is Class C lower Class B but is centrally located! And I’m going to keep my eyes open if and when the market turns southward. I do however need to dig into more detail. One question – do you have a rule of thumb that you use on Class C properties or Class B properties on your estimated repairs & maintenance cost as a percentage of gross rental income? From my banking days, I remember what we used on specific types of commercial properties, but curious how you would analyze that piece of the investment. p.s. I noticed a small typo – you said your 4 units cost $70/each/month for a total of $210…. I think you meant $280. Of course I could have misread it. Cheers!

Good catch on the $210, Liz! I’ve changed it to $280/month. I need to learn math! Lol.

It’s tough to give a rule of thumb. Some people like to use a percentage, like 10% of the rent for maintenance. But as you saw, in my case with lower rents of $500 to $600/unit 10% would have only been $60/mo. It was actually $70/month. Perhaps with higher rents the 10% would be more in line, but I bet repairs also cost more in a higher priced market.

I do like to estimate CapEx and regular maintenance separately in my proforma, although sometimes they get mixed in the reality of every day operations and paying bills.

Yes – congrats on being the high priced market in the chart! You’ll definitely need to look for those C and B- neighborhoods to find a good balance of cash flow. But even then, as that chart shows, your expectations may have to be lower than a similar building in my market for example.

Ha, well you know the only reason I noticed is that I had 10% in my head for repairs and maintenance and when you said 4 units cost $70 and bring in $2200, I realized that $280 was close to 13%. So it was good because it made me think to ask you what your rule of thumb was. And I’m not sure congratulations is in order, lol. Makes me think that I should look outside of SD though I have a much better handle on the market dynamics here. I’m learning more about this stuff every week and just perhaps may dip my feet back into some real estate investing down the road, outside of loans. I always lean on the side of overestimating capex and repairs but I think the point is well taken that you can count a C property to have a higher monthly repair cost. I’m also comparing experience from investors and numbers if properties are used for short term vs. long term rentals. There is a different dynamic there too. Lots of fun stuff to consider.

I’m curious how you would choose where to invest outside your geographic area when the numbers don’t make sense. In the Seattle area where I live, the cost to own exceeds the cost to rent. When I was in graduate school in 2013, I was fortunate to buy a Class B property in a class C neighborhood in Nashville which is now a B+ neighborhood, and it cash flows 700/month and has almost doubled in value. We’d like to invest in a Duplex or 4-plex next, but in the markets we are familiar with, it is difficult to find a property that would cash flow, and having young kiddos, flying to Ohio or Texas to walk the neighborhoods would be challenging. Any advice for investing out of state?

I had property in Atlanta and then moved to California. I could never get the Atlanta property to work for me once I was that far away. My advice is either pay a reliable management company, or only purchase at a distance that you feel comfortable driving the round trip at short notice. For example, the water heater fails and has to be replaced within 48 hours. You need to assess the situation immediately and ensure the replacement is completed. It will take either a good management company or one or two round trips in two days.

It’s true that cash flow properties are tougher today (2018) than in the past. Overall investment rates and interest rates have been compressed for a while.

Related to this article – I’d find more B or C class cities or regions that have long-term potential. There are a lot of locations in the south (you mentioned Nashville, for example). The midwest also has promising locations. Of course, it’s more work getting a remote investing operation up and running. But starting with “fertile investing soil” makes the work worth while.

And as Mark mentioned, you certainly want to have a good team on the ground. A competent property manager is a must in my opinion. It will make your long-distance investing experience much better.

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